Q.9. I'm Uncomfortable with the "Sales
Culture" of My BD/Dual Registant Firm / Insurance Firm. What Should I Do?

Q.10. I'm an
Executive at an Independent, Regional Broker-Dealer Firm. What is the Best Way
to Begin to Comply with the DOL's Rules, and the Expansion of Fiduciary
Standards, Generally?

Q.11. I work in an asset management firm
(i.e., a mutual fund / ETF complex). What should we be doing?

INTRODUCTION.

Since my appearance on Barry Ritholz's "Masters in Business" Bloomberg Radio show
(released Saturday, Jan. 15, 2016), I've heard from many listeners ... several
of whom posed questions - the answers to which may interest others in the
financial and investment advisory communities.

Registered representatives (RRs) of broker-dealer (BD) firms, as well as dual
registrants (possessing licensure as both RRs and investment adviser
representatives) have reached out to me to seek to understand their fiduciary
obligations. A few brokers/dual registrants have stated that they feel
uncomfortable working in their firms' "sales cultures."

A couple of independent broker-dealer (BD) firm executives have questioned me
on how they might survive the transformational changes coming in the years
ahead, as the fiduciary standard is applied.

Fee-only advisers have generally applauded my comments, as have advisers from
the UK and Australia and Canada. Each of these countries continues to move
toward a bona fide fiduciary standard of conduct for those who provide
personalized financial planning and/or investment advice.

Permit me to advance my previously planned closing post in this series,
"Who Moved My Cheese? - The Future of Financial Advice," in order to
respond to some of these specific questions.

Q.1. What is the status of the U.S.
Department of Labor's (DOL's) "Conflict of Interest" (Fiduciary)
Rule?

I anticipate the rule to go to the White House's Office of Management and
Budget (OMB), for an economic review, by January 31, 2016. While the OMB has 90
days to review the rule, I expect that an expedited review will occur, and that
the "Final Rule" will be issued by the DOL in March 2016. Look for an
implementation date of many of the rule's provisions some 8 months later -
i.e., around November 2016.

It is possible that the U.S. Congress could enact legislation to stop the DOL.
The fourth (or fifth?) attempt in the past several months, now pending in
Congress and likely to be marked up in the U.S. House of Representatives in
late January or early February, is the combination of the The Strengthening Access to Valuable Education and Retirement
Support (SAVERS) Act, by Rep. Roskam, and the Affordable Retirement Advice Protection (The ARAP) Act,
by Rep. Roe. The combined effect of the bills would be to stop the DOL
processes. I'll write about the substance of these bills, in a later blog post
or article in an industry publication. Suffice it to say for now that the
combined effect of these bills would result in a worse outcome for
consumers of investment advice than exists under present law.

However, Wall Street is not "in favor" on Capitol Hill these days.
While the bills will likely pass in the House, it seems unlikely (but not
impossible) that 60 votes will be secured in the U.S. Senate to pass the
legislation. Even then, insufficient votes would exist to overturn a promised
Presidential veto.

I anticipate another attempt after the Final Rule from the DOL comes out, and
possibly more attempts after that, later in 2016. Having recently visited with
Congressional staff, it is readily apparent that Capitol Hill is experiencing
the most comprehensive, expensive lobbying effort it has seen in several years
- courtesy of many firms in the broker-dealer community, life/annuity insurance
companies and agents, and certain asset managers.

Yet, there does not appear to be any "must pass" legislation
President Obama needs, between now and the end of his term. In other words,
there does not exist any good reason for President Obama to horse trade, on
another issue, and give up his strong support (to date) of the DOL bill.

Of course, anything can happen, on Capitol Hill. Yet, there are many groups
working together (including the Financial Planning Coalition, CFA Institute,
AICPA/PFP, and the Save Our Retirement Coalition) which oppose the concerted
effort by Wall Street and the insurance companies.

Still, for every one visit members of these groups make to Capitol Hill, there
seem to be 30, 40 or even 50 visits by Wall Street BD firms, certain asset
management firms, insurance companies, and their armies of paid
lobbyists.

In conclusion, while the prospects for the DOL rule are now quite strong,
there still remains a small risk of Congressional intervention prior to the
rule's implementation date.

Q.2. Will the DOL's Final Rule Be
Significantly Changed from its April 2015 Proposed Rule?

Not likely.

We don't know the text of the DOL's Final Rule yet (when discussions with the
DOL occur, the DOL does not reveal its hand, nor are drafts of the Final Rule
ever circulated outside the DOL), so this is tough to answer. But I'll provide
some of my own thoughts.

I don't expect a huge amount of changes. Some of the disclosure obligations may
be lessened. A new exemption might be enacted relating to rollovers of defined
contribution plan accounts to IRAs by fee-only investment advisers (which
technically results in a prohibited transaction, in many instances). At the
same time, some strengthening of parts of the rule might occur. For example,
certain exemptions (the "Best Interests Contract Exemption" or BICE,
and the Education Exemption) could be sunset after a period of years (this is
an idea I've floated; it's far-fetched, but possible). Expect nonpublicly
traded REITs, hedge funds, and a slew of other investments to be prohibited
under BICE.

I do expect that the DOL's rule will continue to apply to nearly all defined
contribution plans governed by ERISA (such as 401k plans, some 403b plans,
etc.), and to all IRA accounts (including traditional IRAS, Roth IRAs, SIMPLE
IRAs, and SEP IRAs). Add it up, and 40% of all publicly traded investments will
be covered by DOL's fiduciary standard (DB, DC, and IRA accounts). Add in
foundation/endowment accounts, and investment advisory accounts, and we are
clearly over 50% of assets governed by the DOL's rule. This is clearly a tipping
point.

If, as expected, the "Best Interests Contract Exemption" (BICE)
remains part of the rule, it is technically possible for BDs to continue to
sell investment products on a commission basis, and for which the firm
receives other third-party compensation (12b-1 fees, payment for shelf space,
and other revenue sharing arrangements). While some of the initial and ongoing
disclosure obligations under BICE may be minimized in the final rule, BICE is
likely to retain three key requirements:

First, under the mandatory standards of impartial conduct,
that the compensation received be "reasonable."

Second, under the mandatory standards of impartial conduct,
that the recommendations by the adviser be in the client's best interest.
“Best Interest” is defined to require the Adviser and Financial Institution to
“act with the care, skill, prudence, and diligence under the circumstances then
prevailing that a prudent person would exercise based on the investment
objectives, risk tolerance, financial circumstances, and the needs of the
Retirement Investor.” The "Best Interest" standard is ERISA-based and
the DOL stated that it expects the "Best Interest" standard to be
interpreted “in light of forty years of judicial experience with ERISA’s
fiduciary standards and hundreds more with the duties imposed on trustees under
the common law of trusts.” Under it, the Adviser and Financial Institution must
make recommendations without regard to the financial or other interests of
the Adviser, Financial Institution or any Affiliate, Related Entity, or other
party.

Third, that the client is provided certain warranties by
contract, which include but are not limited to:

that
the financial institution has adopted written policies and procedures
reasonably designed to mitigate the impact of material conflicts of
interest and ensure that the advisers adhere to the impartial conduct
standards;

in
formulating its policies and procedures, the financial institution
specifically identified material conflicts of interest and adopted
measures to prevent the material conflicts of interest from causing
violations of the impartial conduct standards; and

neither
the financial institution nor an affiliate or related entity uses quotas,
appraisals, performance or personnel actions, bonuses, contests, special
awards, differential compensation or other actions or incentives
that would tend to encourage advisers to make recommendations that are not
in the best interest of the retirement investor.

The U.S. Department of Labor provided, in its April 2015 proposed rules, five
examples of how the receipt of commission-based or other third-party compensation
by a firm could occur. These include two non-differential compensation
methods: (1) AUM-based level compensation; and (2) fee offsets, such as
crediting 12b-1 fees or other compensation received against other fees
received, to maintain level compensation.

Another example permits "differential payments based on neutral
factors" (such as greater time required to explain a product or undertake
due diligence on same). Another example provides that a firm's compensation
structure is "reasonably designed to align the interests of the Adviser
with the interests of the Retirement Investor." I expect the DOL will
"tighten up" both of these examples, in the Final Rule, so that these
examples are not interpreted in such a manner that the essence of the rule is
negated.

Q.3. Will "Differential
Compensation" Be Permitted under the DOL's Fiduciary Rule?

In essence, differential compensation is permitted for certain investment
advisers under the Investment Advisers Act. For example, look at hedge fund fee
arrangements, which provide additional compensation dependent upon the returns
of the funds.

However, unlike
performance-based compensation schemes, the plain truth is that higher
compensation - to firms (Financial Institutions) and/or to their individual
advisers - typically results when the investment product has higher management
fees (leading to certain forms of revenue sharing, 12b-1 fees, or other fees.
And, as I've discussed previously in this series, the
academic evidence is compelling that a mutual fund (or ETF, or variable annuity
sub-account, or other pooled investment vehicle) that has higher fees and
costs is highly likely to underperform, especially over the long term. And
the DOL fully understands this relationship between higher fees and lower
returns.

In my view, firms and advisers are permitted to be paid different types
of compensation, but the DOL's rules are likely to be interpreted in such a
fashion that differential compensation becomes problematic. You simply
can't adhere to your fiduciary duty to act in your client's best interests if
you charge a higher fee for the sale of one product versus another product, all
other things being equal. Outside of the area of performance-based fees (such
as those seen in hedge funds), the more compensation you receive, the less the
returns are likely to be for the client. You might seek to "disclose"
this fact to the client, but the reality is that disclosure, alone, is
insufficient; the fiduciary standard requires the informed consent of
the client to any conflict of interest - and no client would consent to be
harmed. Additionally, the fiduciary duty of loyalty also requires that the
proposed transaction remain substantively fair to the client, and it is not
"fair" if the higher compensation you (or your firm) receives results
(as is extremely likely) in lower returns for the investor.

The
receipt of additional compensation for recommending one product over
another is a conflict of interest. As I've written about previously, a conflict
of interest is a breach of one's fiduciary duties. The "best
interests" standard present in the Best Interests Contract Exemption
permits you to seek to "cure" this breach - but only by
following a very strict set of steps.

Firms will need
to adopt level compensation arrangements. For example, a fee agreement for
serving a smaller client (say, $25,000 or less to invest) might state:
"Our fee will be a 5.75% commission, or less, upon the sale of the mutual
fund."

Alternatively, level compensation arrangements in the form of assets under
management, retainer fees, subscription fees, and hourly fees (or some
combination thereof) will likely be adopted for larger clients. And that means
Series 65/66 licensure for the individual adviser, if not already obtained.

In either instance, I believe asset management firms and broker-dealer firms
will need to quickly adapt, in order to avoid payment for shelf space and
most other revenue-sharing arrangements.

The DOLis unlikely to overtly challenge the making of 12b-1 fees.
However, the reasonableness of such fee payments is certainly an issue under
BICE's requirements, especially for larger accounts. In fact, there are so many potential problems with 12b-1 fees
that I would advice asset management firms to phase them out, altogether. And I
would suggest to RRs and dual registrants that they don't build their practices
around the continued receipt of 12b-1 fees.

Soft dollar compensation payments might still be permitted, but we will
have to see if the DOL imposes any restrictions on them - such as verification
that the total amount of the soft dollars reflects a price for the research
supplied by a BD to an asset management firm that is reasonable, given the
marketplace for such research. Even if the DOL does not explicitly impose such
a requirement, the BD might need to make a determination of such
reasonableness, given the requirements of BICE.

Q.4. What Constitutes a "Reasonable
Fee" Under the Fiduciary Standard?

While regulators don't like to opine as to what is "reasonable" or
"not reasonable" as to compensation arrangements, the interpretation
of "reasonable" in a fiduciary context is altogether different than
that found under FINRA's rules. The fact of the matter is that fiduciaries are
regarded as professionals, and the compensation received must be reasonable
given the time and expertise required to provide the services, as well as
considering the risks assumed by the adviser.

Just as an example, it is highly unlikely that the sale of a $500,000 variable
annuity, paying to a firm a 5% commission ($25,000), during the IRA rollover
process, would be considered "reasonable." At the same time, a 5.75%
commission on the sale of a $24,000 mutual fund, leading to $1,380 in
commission, may well be reasonable.

Similarly, a 2% asset-under-management fee, assessed on a $10,000,000 account,
resulting in $200,000 of compensation each year to a registered investment
adviser (RIA) firm or dual registrant firm, is unlikely to be considered
reasonable, without documentation of a wide array of time-consuming services to
the client as part of such fee.

The "reasonable fee" requirement will likely only be resolved, over
time, via the use of experts, in the context of litigation (or, more likely,
arbitration).

(Be forewarned that FINRA's standards for maximum compensation are highly
unlikely to be adopted as "reasonable" compensation for a fiduciary,
especially when larger amounts of assets are being managed.)

Benchmarking of fees will likely occur during expert testimony. However, in
each instance the amount of services provided, and the skill with which those
services were delivered, will be significant factors. As a result, there won't
be a set "maximum fee schedule" adopted by the industry, nor by
finders of fact in the context of dispute resolution.

Q.5. Is Asset Management Becoming
Commoditized?

I don't know if "commoditized" is the correct word. It implies a
level of uniformity and plentifulness among investment options that does not
exist at present (except, arguably, for S&P 500 Index funds).

While low-cost index funds exist that can be recommended to clients, not all
index funds track the same indexes (even with an asset class), and other
distinctions exist (such as the amount of cash holdings, use or non-use of
securities lending and whether securities lending revenue is shared with
affiliates, etc.)

Some funds [such as those of Dimensional Funds Advisors (DFA) might be
considered "actively managed" by some advisers, while others consider
them "passive" funds. DFA's funds don't track commercial
indexes (in order to avoid the advance publication of index reconstitution, and
its deleterious effects on prices during the subsequent reconstitution
process). Rather, in essence, DFA has privately constructed portfolios,
although they are very well-diversified (like many index funds) and appear to
apply certain quantitive rules as to stock inclusion in the "private
index." Even then, trading rules exist for DFA funds (as a means of
lowering transaction costs, and/or taking advantage of the momentum effect)
that cause deviation even from its own "private" list of desired fund
holdings. Addtionally, the long-term track record of many of DFA's funds shows
a substantial outperformance over commercial indexes (of some 50 basis points
or greater), over many rolling time periods.

To a far lesser extent, some evidence exists that Vanguard's actively managed
funds outperform its own index funds, although the amount of such average
outperformance is so small as to be statistically insufficient to support the
conclusion of the superiority of Vanguard's active managers (at present, given
the limited amount of historical data).

Perhaps the better phrase is that asset management services provided by
investment advisers are less time-intensive, given the use of rebalancing and
other software solutions, and that it is "scaleable" to a
large degree. Hence, I anticipate continued downward pressure on investment
adviser fees, especially when the adviser's business model is to select and
then management a portfolio of mutual funds or other pooled investment
vehicles.

While some advisers might be tempted to manage individual stock portfolios,
as a means of receiving greater compensation (i.e., by capturing the fees that
would otherwise be paid by a client for low-cost mutual funds), caution must be
exercised. Substantial diversification necessary to minimize the risks of
underperformance of a benchmark requires hundreds of individual stocks -
not just a few dozen. While many bank trust departments continue to run
"30-stock" portfolios, under the observation that the standard
deviation of a 30-stock portfolio is near that of a highly diversified stock
fund, it must be recognized that standard deviation is only one measure of risk
(and often a poor measure, at that). Additionally, transaction costs must be
effectively managed, such as through block trading and other techniques; many
mutual funds possess substantial expertise in their trading desks to enable
transaction costs to be minimized (although, for larger funds, especially large
index funds, market impact costs can be quite high).

I'm not stating that individual stock portfolio management is not possible
under the fiduciary standard. With economies of scale achieved in some manner,
and by keeping trading costs to minimal levels (made more possible, among large
cap U.S. stocks, due to lower bid-ask spreads resulting from decimilizaton and
the impact of high-frequency trading), it is possible to run a portfolio of
individual stocks for clients - at least in the U.S. large-cap asset class
space. Yet, the costs of doing this may well outweigh the benefits - for both a
firm and for the client - unless substantial economies of scale are achieved
and transaction costs are strictly controlled.

The major dilemna for advisers is their value proposition when it comes
to fund selection. If the adviser undertakes due diligence in mutual fund / ETF
/ separate account selection (whether adhering to a passive or active
investment philosophy), given the scaleability present an increasing number of
clients question the assets-under-management fees charged for such activities.
In essence, clients desire to receive the benefits of the scaleability present,
rather than the firm keeping most of scaleability's benefit for itself.

Q.6. How Can We Scale Our Financial Planning
Practice?

I
think that financial planning can be made more efficient, in some of its
phases. Such as data collection, and the dissemination of reports and other
information to clients, via good web interfaces and software deployment.

At the same time, I think many financial planning decisions still involve the
time of an experienced, expert planner who looks at the "big picture"
before final recommendations are made. I have not yet run across financial
planning software that accurately determines a client's need (rather
than tolerance) for risk. Nor does financial planning software do an
outstanding job of "connecting the dots," particularly as to the
interplay of various risks present in a person's life. And financial planning
software is not as impactful in the delivery of advice; a good adviser can,
through emphasis and body language, persuade a client toward a course of
action, in a way that a piece of paper or an electronic screen cannot.

Hence, while certain efficiencies can be achieved, I don't believe that
financial planning is "scaleable" - certainly not in the way that
investment management is scaleable. Rather, efficiencies can be brought to
various aspects of the financial planning process (at the risk, at times, of
losing the "human touch"). And, through the use of associates and
junior partners, senior partners can achieve some leverage. In other words,
financial planning is best undertaken using the business model of a
professional services firm.

Q.7. Will "Investment Advice"
Become Distinguishable from "Financial Planning" Advice?

Yes, and no.

No, in the sense that a certain level of fundamental financial planning, in
my view, is a prerequisite to the delivery of financial advice.

For example, suppose a prospective client comes to you with $100,000 cash, just
inherited, and wants you (the investment adviser) to invest those funds. Yet,
in the process of gathering client data (required to meet your fiduciary
obligations to the client), you discern that the client has a $20,000 credit
card bearing 18% interest, a $15,000 car loan bearing 6% interest, and that the
client has a 95% loan-to-value $120,000 mortgage on which private mortgage
insurance is being paid. Additionally, the prospective client has no cash
reserve. Also, you discern that the prospective client is not contributing to
her 401k account, and that the employer provides a match up to 3% of salary.
The client also has insufficient term life insurance, and insufficient personal
liability insurance. If the aforementioned credit card debt and car loan were
paid off, and the mortgage amount reduced to avoid PMI, enough income would be
freed up to easily foster 401k contributions as well as purchase term life and
personal liability insurance. What should you do?

The legal aspect of this question revolves around whether you can, as a
fiduciary, limit the scope of your engagement (advice) to simply
designing and implementing an investment portfolio. And, for the answer to this
question, perhaps we should look to the investment adviser representative
(Series 65 exam) topic list, which includes among its many topics the
following:

Client
profile

1. financial goals and strategies:

a. current income;

b. retirement;

c. death;

d. disability;

e. time horizon.

2. current financial status:

a. cash flow;

b. balance sheet;

c. existing investments;d. tax
situation.

Arguably,
gathering the information for a proper client profile - as suggested by the
topics in the Series 65 exam, and in your role as a fiduciary adviser - is done
with a purpose in mind. And that purpose is to achieve a proper use of
available funds, whether they are used to pay off or down debt, fund a cash
reserve or retirement accounts, or implement insurance purposes to reduce some
of life's major risks.

In essence, investment advisers to individual consumers are financial
planners, first, and investment advisers, second. We must understand that
investment advice to individuals cannot be delivered in a vacuum.

Hence, I would opine that some level of financial planning is therefore a
necessary prerequisite to the investment of client funds. At a minimum, you
may be required to refer the client to a financial planner (assuming you don't
possess those skills, or that you don't desire to undertake those services).

In
recognition of the need to provide an arrange of services to clients, in
order to meet the clients' needs, many larger RIA firms and dual
registrant firms are establishing teams. The roles may vary from business
development to trading to portfolio decision-making to financial planning.
Many RIA firms also provide tax compliance (i.e., tax return preparation).

Let me now turn
to the "yes" part of this answer. Yes, I believe financial planning
fees will likely become separate from investment advisory fees, at some point
in the future.

Financial planning fees may well become bifurcated from investment advisory
fees. As stated above, investment advice is scaleable. But financial planning
requires the time of a professional, and while efficiencies can be achieved
through selective use of various software solutions and leveraging can be
obtained via the use of associates or junior partners, it is difficult to scale
professional services.

This may appear contrary to my stated view that investment advice does not
exist in a vacuum, and that financial planning is also required. Yet, financial
planning is, rather, a prerequisite and co-requisite with investment advice;
the functions themselves are divisible within a firm. And investment advice is
to a large degree scaleable, which permits different fee arrangements than
largely non-scaleable financial planning.

Financial planning is time-intensive, and a substantial level of expertise is
required. I often tell my students that I can turn you into an excellent
investment adviser within a year (of working in a firm), but that it will take
5-10 years for you to become an experienced and excellent financial planner.
There exists both breadth and depth of the financial planning knowledge
required, and it takes time to be able to "connect the dots."

A simple example involves how a decision in one area (such as the purchase or
non-purchase of long-term care insurance, the amount purchased, the quality of
the insurance company, the presence of state partnerships for LTCI, etc.) could
affect another area of financial planning (the amount of savings required for
retirement, Medicaid advance planning, the use of trusts between spouses,
etc.).

I believe that most advisers want to do the right thing for their
clients. But, over time, the incentives they receive - for pushing certain
products, for achieving certain sales goals for a particular product, etc.,
combine to unconsciously influence their decision-making. (And it is this
"unconscious influence" of conflicts of interest that so many jurists
warn fiduciaries about, including the U.S. Supreme Court's warning about such
influences contained in its landmark SEC vs. Capital Gains Research Bureau
1963 decision.)

Alternatively, even those advisers who resist temptation often are directed, by
their firms, to push certain products that provide higher commissions, or which
provide 12b-1 fees or payment for shelf space of other additional compensation
to the firm. In perhaps the worst transgression, some firms push their advisers
to sell proprietary mutual funds or other proprietary products. (I'll write
about the inherent problems of proprietary products, in a later post.)

There are several dynamics at play, in the relationship between a
broker-dealer firm (or dual registant firm) and its registered representative
(or dual registrant adviser).

First, the firm's reputational risk is usually far below that of the
individual adviser. Advertising and promotion, along with arbitration and
private settlements of disputes, mean that firm's reputational risks are
minimized, or that their reputations can be quickly restored (the public has
short-lived memories). In contrast, a single complaint against an individual
adviser can result in a stain on the adviser's U-4. Additionally, firms have an
economic incentive to settle complaints that are small, or that are unlikely to
prevail, for small amounts, even though the adviser's reputation might be
ruined, and the adviser would prefer that the complaint proceed through
arbitration.

Second, under the DOL's rules, the individual adviser must not receive
differential compensation, but the firm can. Given such, some firms will
continue to insist that products which provide differential compensation to the
firm be sold. Even though the adviser knows, intellectually, that higher
compensation to the firm results from higher-fee products which, on average,
result in lower returns to the client. This development marks a further
divergence of the interests of the firm, from those of the adviser.

Third, the cost structures of many broker-dealer firms, and dual
registrant firms, in terms of the amount of support staff they possess at their
headquarters (and other locations) to support the sales force in the field, simply
cannot support the reduced level of compensation likely to result from the
fiduciary standard of conduct. In contrast, fee-only firms are "lean
and mean." Unlike what many individual advisers have been told, the
compliance costs from acting as a bona fide fiduciary - in which conflicts of
interest are avoided (not just disclosed) - and in which proper (and extensive)
due diligence is undertaken on investment strategies and investment products -
are quite low compared to those of broker-dealers. And the liability insurance
costs are lower, as well, for those who avoid conflicts of interest.

Fourth, senior partners of the firm, and/or senior executives, don't make
tens of millions of dollars in most fiduciary firms. They may receive
millions (7-digit) compensation, but rarely (if ever) do they receive the
8-digit compensation seen in many of the larger broker-dealer firms.
Professional services firms simply don't support such high levels of executive
compensation.

Fifth, broker-dealer firms with associated investment banking operations -
i.e., those firms that engage in securities underwriting, use the retail
sales force to support the distribution of stock and IPOs and newly issued bond
and other securities. Yet, academic research demonstrates that, during most
periods, returns for IPO stocks underperform the broader market over the first
few years. (Some speculate that this is due to mispricing, resulting from
overhyping the stock, or other reasons.)

Also, witness the manufacture and sale of mortgage-backed securities containing
subprime loans, or the sales of alternative investments in recent years that
have "blown up" in the face of the firm and the adviser. Other
examples include the sale of non-publicly traded REITs that have blown up in
the face of some firms and their individual advisers (see, e.g., the Apple
REIT litigation), oil and gas limited partnerships, and other products that
pay high commissions (often 10%, plus marketing support dollars often equal to
another 2% or more) to the firm.

The result of this dynamic is that many broker-dealer firms make a lot of money
selling sub-par investments. And, to protect their own reputations, I have long
advised RRs / dual registrant advisers in these firms to undertake their own
extensive due diligence on the investment strategies they choose to employ, and
on the specific investment products they recommend, prior to the sale of the
products to any clients. The level of fiduciary due diligence required is
large. Yet, due to pressures on the top line and/or the bottom line, many BD's
firms due diligence processes are insufficient to protect them from claims, and
to protect the advisers in those firms. For many firms, getting "caught"
(whether in the context of private litigation/arbitration, or by regulators) just
results in a "cost of doing business" - for they have made
substantial sums from their sales of products and the underwriting of them. But the consequences for individual advisers are huge.

Individual advisers in BD and dual registrant firms need to undertake their own due
diligence, if they are at all concerned over their own reputational risks, to protect themselves.

BUT ... not all firms are reckless. Indeed, some large BD firms are
beginning to transition to bona fide fiduciary (and near conflict-free)
platforms in which the firm receives an AUM fee (and the adviser receives a
portion of same), and in the accounts are held only low-cost ETFs (with no
revenue sharing present). In some situations 12b-1 fees and other revenue
sharing fees, if received by the brokerage firm, are offset against the
advisory fees charged. These moves are to be applauded, and such platforms
should be embraced by the advisers in those firms.

Q.9. I'm Uncomfortable with the "Sales
Culture" of My BD/Dual Registant Firm / Insurance Firm. What Should I Do?

If you are
uncomfortable with your BD firm's approach to supporting your adherence to your
fiduciary obligations, I would suggest you consider speaking with your
superiors in the firm. Chances are that the firm will be rolling out platforms
for the delivery of fiduciary advice, in the near future.

In the interim,
seek out the most conflict-free platform that the BD firm provides, and serve
your clients that way. If, however, conflicts of interest persist, and no
appropriate platforms are provided, you will have the tough decision as to
whether to remain in that environment over the long term. A myriad of factors
come into play, of course. An adviser, prior to making any decision to leave a
firm, would be served to consult with a securities attorney who specializes in
advising departing advisers. The adviser would also need to spend extensive
time investigating "where to go to" - perhaps aided by education from
NAPFA (the largest fee-only financial adviser organization), Garrett Planning
Network, XY Planning Network, Alliance of Comprehensive Planners, various
independent dual registrant firms that possess a fiduciary culture, various
"roll-up" firms that acquire larger practices, and independent RIA
firms.

If you work for
an insurance company, and its affiliate BD, expect a harder path to the
fiduciary standard. I have not seen any large insurance company adopt a
platform in its BD affiliate that enables a conflict-free fiduciary practice
methodology.

Q.10. I'm an Executive at an Independent,
Regional Broker-Dealer Firm. What is the Best Way to Begin to Comply with the
DOL's Rules, and the Expansion of Fiduciary Standards Generally?

As the question suggests, fiduciary obligations
don't just flow from the DOL's proposed rule. They are also imposed under the
Investment Advisers Act of 1940, as well as state common law (when either de
facto discretion exists, or a relationship of trust and confidence exists
between the broker and the client). And fiduciary obligations can result from
adherence to certain professional organizational standards.

If you are asking this question, you have a
great deal of work ahead of you, in a small period of time. You need to act
fast, before change passes you by and the revenues and cash flow you need to
effect change disappear. Alternatively, if you don't possess cash flow
sufficient to implement the changes required, consider a merger with another
firm.

I would suggest that you begin to look at the
most important job ahead of you - transitioning the firm away from a
"sales culture" to a "fiduciary culture." Changes in
culture require time, and effort. And they are never successful unless they
flow, correctly and in a well-planned manner, from the top down.

Understanding why fiduciary obligations are
imposed, and what is required under a bona fide fiduciary standard, is
part of your initial homework assignment. The fiduciary standard is a very
strict standard; it is far more than serving up "good products."

But, if you truly understand the fiduciary
standard's many requirements, you will find that it is easy to comply with. And
your advisers will discover new happiness in coming to work, as they serve the
best interests of their clients.

If you have asset management affiliates,
consider divestiture of them.

If you engage in underwriting stocks and bonds,
consider the culture of underwriting that existed among top firms 20 years ago,
and how to return to that culture.

Start with the proper goals in mind. You desire
to be the best firm - able to attract and retain the best talent, and able to
provide the best value-added services to your clients.

Lastly, promote your firm's new fiduciary
culture to the public, once you are ready. It's a significant marketing
advantage, if you explain it correctly - to both your current clients and to
prospective clients. You don't have to use the word "fiduciary" -
find other words that impart that your firm is the steward of your clients'
hopes and dreams, not just their wealth. Be deserving of your client's trust.

I hope that the blog posts I've previously
posted, this month and in prior years, can assist you in this process and
journey.

Q.11. I work in an asset management firm
(i.e., a mutual fund / ETF complex) that sells through intermediaries. What should we be doing?

Your firm should be speaking
to its customers (brokers, investment advisers, etc.). Your customer's needs
are changing, and you need to change with them.

If
you wait too long, your current revenues will decline as the competition races
ahead. Lacking profits and cash to fuel change, you will be forced to merge
with other firms.

Design
new compensation structures, within your products, that will better meet the
fiduciary requirements of the DOL rule.

For
example, establish share classes that provide negotiable sales loads,
regardless of whether breakpoint discount levels are achieved. Provide other
share classes with no sales loads of any kind.

For
all new share classes, eliminate 12b-1 fees (a controversial move, to be
certain, but one that will pay off in the long run). Eliminate payment for
shelf space. Reduce investment adviser (management) and administration
expenses. Don't pay soft dollars anymore. Sell your products on the basis of
their high quality, rather than the extra compensation they provide to the
intermediary firm (since such differential compensation will be problematic, in
the future).

Build
better investment strategies. Hire finance professors who are well-versed in
the many "factors" emerging from academia (i.e., the "factor
zoo), but who are also pragmatic enough to ensure that any factors applied in a
fund possess a very high probability of adding value over the long term. Don't
pay fund managers exorbitant fees, however.

Consider
designing broad market funds, with factors, that result in little need for
trading within the fund.

There
will come a time when every fiduciary adviser will seek out tax-efficient funds
for taxable accounts. Always possess mutual fund or ETF offerings designed for
investing in taxable accounts. Mutual funds may be called tax-aware,
tax-efficient, or tax-managed. establish methodologies to eliminate short-term
capital gain distributions, to limit long-term capital gain distributions, and
to seek qualified dividend treatment where available. Especially pay close
attention to international stock funds in this area, in order to pass through
tax credits.

Consider
the use of the ETF structure (and its unit creation and unit disposition methods)
to achieve even greater tax efficiencies (but watch out for IRS regulations or
rulings in this area, that may in the future negate such advantages). However,
ETF transparency can increase market impact costs.

If
using index funds, consider the choice of a better index, to limit portfolio
turnover. Also, the more funds that track an index, generally the more market
impact costs. Perhaps the better solution is to possess low-cost funds in which
you create your own index, but don't publicize it. Why let everyone know, in
advance, your trades?

If
you advise on IRA rollovers, realize that your sales force will need better
training in connection with many factors present in the IRA rollover process.
Expect some guidance from the DOL on this, in their final rule, but be prepared
if the DOL does not provide more substantive guidance.

For
those in the variable annuity business, massive changes are likely needed. See
my prior blog post on variable annuities, and cost/benefit analyses for VAs.
There are emerging several VAs that are attractive to fiduciary advisers; find
a way to have products that are even more attractive by stripping bare many of
the guarantees. (Just because a guarantee is potentially costly to your
company, because of the potential risks - including tail risks - assumed, does
not mean that the guarantee is just as valuable to your customer. There are
other alternatives to manage risk.) Focus on gaining market share, while others
resist change.

For
those who issue equity indexed annuities (EIAs) (or insurance companies
considering same), consider building a fully transparent, no-load (and/or
reduced load) product that delivers more returns to investors. It is possible
to have EIA structures that pose very little risk to the insurance company, in
terms of the necessity of setting aside monies for guarantees. Provide a
"stripped-down" product. See my prior post on EIAs.

Again,
get ahead of the curve, and gain huge market share. Because, in a future era of
lower fees, only those who possess huge market share will be able to leverage
economies of scale and remain highly profitable.

A shake-out is coming in the
asset management industry, and you don’t want to be the one shaken out.

CHANGE IS COMING. Don't dawdle
... "Who Moved My Cheese?"

---------------------------------------------------------------------

Ron A. Rhoades, JD, CFP® is the Program Director for the Financial Planning
Program and an Asst. Professor of
Finance at Western Kentucky University, at its beautiful main campus in Bowling Green,
KY. He is a CFP certificant, a regional board member of NAPFA, a
consultant to the Garrett Planning Network, and a member of the Steering Group
for The Committee for the Fiduciary Standard. Ron previously served as Reporter
for the Financial Planning Standards of Conduct Task Force and Fiduciary Task
Force, and as a consultant to a major financial services firm on a project
involving IRA rollovers.

An
estate planning and tax attorney (Florida), and a fee-only investment adviser,
Ron provides instruction to highly motivated students at Western Kentucky
University in courses such as the Personal Financial Planning Capstone, Applied
Investments, Estate Planning, and Retirement Planning. He has previously taught
courses (at another college) in Insurance and Risk Management, Advanced
Investments, Employee Benefits Planning, Business Law I and II, and Money &
Banking.

This
blog represents Ron's personal views and is not necessarily indicative of the
views of any institution, organization or firm with whom he may be associated.

Ron
is scheduled to provide two presentations in early 2016 on the DOL's rules and
the general impact of the fiduciary standard on the financial services
industry:

Post a Comment

Ron's College Student Success Blog

Please visit www.blogspot.triumphincollege.com.

Search This Blog

Explore WKU's Nationally Renowned Financial Planning Program

The nationally recognized WKU Financial Planning Program challenges and empowers, developing students into exceptional and highly ethical professionals who go on to pursue highly successful financial advisory careers and who possess highly meaningful lives.

Led by Asst. Prof. Andrew Head, CFP® and Dr. Ron A. Rhoades, CFP®, with contributions from other WKU's Finance Department faculty, students receive a solid foundation in the very broad, yet very deep, areas of financial planning and investments. Throughout the curriculum emphasis is placed upon the acquisition of practical knowledge as well as the development of exceptional counseling, presentation, and interpersonal skills.

Check us out! Visit the WKU Finance Department web pages to learn more. For more information about our innovative program and project-based learning, please contact Dr. Rhoades or Professor Head.

About the Author

Ron A. Rhoades, JD, CFP® sailed across the Atlantic on a tall ship, performed in theme parks and road shows in Europe and America as a Disney character, rowed on a championship crew team, marched in the Macy’s Thanksgiving Day Parade, marched in competition with a state-champion rifle drill team, undertook a solo one-week trip into the Everglades, escorted numerous celebrities around Central Florida, performed as a “Tin Man” at a mountaintop theme park called “The Land of Oz” in Beech Mountain, NC, and served as a stage manager and talent scheduling coordinator for entertainment productions at Walt Disney World. And then he graduated college.

Since then, Ron Rhoades earned his Juris Doctor degree, with honors, from the University of Florida College of Law, which was preceded by a B.S.B.A. from Florida Southern College. Ron Rhoades has 30 years of experience as an attorney, with nearly all of those years substantially devoted to estate planning, tax planning, and retirement plan distribution planning. Ron also has over 15 years as a personal financial adviser. He was a principal with an investment advisory firm where he served as its Director of Research and Chair of its Investment Committee.

The author of numerous articles published in financial industry publications and several books, Dr. Rhoades has been quoted in numerous consumer and trade publications, and has been interviewed on Bloomberg's "Masters in Business" radio show segment. He writes occasional articles for industry publications. Ron is a frequent speaker at local FPA chapter meetings and national conferences in the financial planning and investment advisory professions.

Ron Rhoades was the recipient of The Tamar Frankel Fiduciary of the Year Award for 2011, from The Committee for the Fiduciary Standard, as he “altered the course of the fiduciary discussion in Washington.” He was also named as one of the Top 25 Most Influential persons associated with the investment advisory profession in 2011 by Investment Advisor magazine, and was voted to the “Sweet 16 Most Influential” in Wealth Management’s 2013 “March Madness” competition. Dr. Rhoades was also named as one of the "Top 30 Most Influential" members in NAPFA's 30-year history in 2013. This blog was also called one of the "Top 25 Most Dangerous" in financial services.

Ron A. Rhoades, JD, CFP® became Program Director for the Financial Planning Program (B.S. Finance, Financial Planning Track) at Western Kentucky University's Gordon Ford School of Business in July 2015. He provides instruction to highly motivated, exceptional undergraduates students in such courses as Applied Investments, Retirement Planning, Estate Planning, and the Personal Financial Planning Capstone course. He has previously taught courses in Insurance & Risk Management, Employee Benefits, Money & Banking, Advanced Investments, and Business Law I and II.

Ron also serves on the Steering Committee of The Committee for the Fiduciary Standard, on whose behalf he frequently travels to Washington, D.C. to meet with policy makers in Congress and in government agencies regarding the application of the fiduciary standard to personalized investment advice.